How Long Has This FINRA Violation Been Going On?
September 8, 2017How long is too long for a Wall Street regulator to investigate allegations of misconduct and either file charges or settle? In a recent FINRA settlement, we are confronted with misconduct that allegedly took place in 2009. Despite having eight years of accumulated wisdom, the self-regulator doesn't explain why a former employer characterized the misconduct as an outside business activity but FINRA charged a private securities transaction. Maybe another two years -- the passage of a decade -- might help to get everything nice and neat?
Case In Point
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, John Hoyt Williams, Jr. submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of John Hoyt Williams, Jr., Respondent (AWC 2013037675101, August 28, 2017).
Williams entered the securities industry in October 1993 as an associated person with a FINRA broker-dealer and its affiliate insurance company. Williams first became registered in 1994. The AWC asserts that in 1999, Willams was registered with FINRA member firm LPL Financial LLC, where he remained until he registered with another FINRA member firm in August 2013. The AWC asserts that "Williams does not have any disciplinary history with the Securities and Exchange Commission, FINRA, any other self-regulatory organization or any state securities regulator."
Collateral and Loans
The AWC asserts that between February and March 2009, Williams referred three LPL customers to a company referred to in the AWC only as "Company." The purported purpose of the referrals was to "obtain non-recourse loans secured by the customers' securities." In describing the the proposed transaction, the AWC states:
[W]hen the securities were pledged as collateral for these non-recourse loans, the Company could not obtain repayment from the customers beyond the pledged collateral. The customers pledged securities valued at approximately $700,000 for non-recourse loans totaling approximately $500,000. The customers ultimately realized gains from the transactions. However they were exposed to the risk of suffering losses in the amount of $200,000.
The AWC alleges that Williams facilitated the transactions by recommending that the three LPL customers pledge securities as collateral for the Company's loans. The AWC characterizes, in pertinent part, Williams' role in the transactions having assisted the customers with completing and submitting the transaction documents. The AWC asserts that by April 2, 2009, Williams had received $12,880 in referral fees from the Company.
Private Securities Transactions!
FINRA deemed the cited transactions as constituting Williams' participation in three private securities transactions ("PSTs") without providing prior written notice to LPL and receiving written approval. The AWC further asserts that:
Outside Business Activities?In addition, on a questionnaire Williams submitted to LPL during 2010, Williams stated that he had not received any referral fees of this type.
According to online FINRA BrokerCheck records as of September 8, 2017, LPL "discharged" Williams on July 5, 2013, based upon allegations of:
VIOLATION OF FIRM POLICY REGARDING OUTSIDE BUSINESS ACTIVITIES
Sanctions
FINRA deemed Williams' conduct to constitute violations of NASD Rule 3040: Private Securities Transactions of an Associated Person (which was superseded by FINRA Rule 3280 in April 2015 and thereafter amended) and FINRA Rule 2010. In accordance with the terms of the AWC, FINRA imposed upon Williams a $10,000 fine and ordered him to disgorge the $12,880 in referral fees via payment to FINRA.
[W]hen the securities were pledged as collateral for these non-recourse loans, the Company could not obtain repayment from the customers beyond the pledged collateral. The customers pledged securities valued at approximately $700,000 for non-recourse loans totaling approximately $500,000. The customers ultimately realized gains from the transactions. However they were exposed to the risk of suffering losses in the amount of $200,000.
Not to be too snarky here but, you know, like, ummm, duh . . . a non-recourse loan is one in which, let's see, oh, yeah, in the event of a default on the loan there is no recourse for the lender beyond the pledged collateral. So, yeah, of course, anyone pledging collateral for a non-recourse loan would be exposed to liability for the full value of the collateral. That's the whole point of making the transaction non-recourse. Accordingly, the issuer of such a non-recourse loan would be foolish not to take into consideration the quality of the collateral and in the case of a pledge of securities, an issuer would normally require a valuation in excess of the principal of the loan because the prices of stocks can decrease over time.
The aspect of the quoted AWC language that rankles me (and, my, I do not like rankles) is that it not only annoyingly restates the obvious but gets in a bit of what I see as a regulatory "kidney punch" by admonishing that the pledging customers were exposed to the "risk of suffering losses in the amount of $200,000." Talk about restating the obvious squared! When was the last time you saw a FINRA AWC or any regulatory Decision state that when a customer purchased, say, $200,000 of Facebook or Apple stock that "they were exposed to the risk of suffering losses in the amount of $200,000?"
It comes off as disingenuous when a financial services regulator wrings its hands over how customers realized gains from their pledge of collateral but were exposed to the "risk" of losing the full amount of their pledged securities. Again, ummm, you want me to explain the mechanics of pledging collateral for a loan? Do the same risk-reward concerns not arise with similar import within the context of an investment in a municipal bond or REIT or any number of investments? Do I not incur the same risk when purchasing a multi-million vacation home in the Florida Keys?
If FINRA wants to allege that Williams' customers had complained that they were unaware of how a non-recourse loan functions or were mislead by Williams about the risk of their pledged securities, then the regulator should have noted such allegations in the AWC. I am not arguing that the lack of such complaints by the three customers would alter the existence or legitimate concerns about an unauthorized PST or OBA. Such complaints are beside the point. A violation is a violation even if a customer is thrilled with her profits from such a questioned transaction. On the other hand, in a FINRA regulatory settlement involving alleged misconduct that's over eight years old, the regulator should make more of an effort to place events in their proper context and with the benefit of hindsight that such an extended lapse of time affords.
In a recent Financial Industry Regulatory Authority ("FINRA") regulatory settlement, a stockbroker was barred from the industry as a result of allegedly failing to properly notify his employer and obtain its approval for soliciting firm customers to invest in his own company. As BrokeAndBroker.com Blog's publisher Bill Singer, Esq. notes, the published settlement is a bit perplexing because it seems to be start off as an Outside Business Activity violation but winds up as a Private Securities Transaction violation. With the football season nearly upon us, let's just say we got a bit of a regulatory misdirection play going on here.
That BrokerCheck disclosure doesn't jibe with what's set forth in the "Background" section of the AWC:VIOLATION OF FIRM POLICY REGARDING OUTSIDE BUSINESS ACTIVITIES
Williams entered the securities industry in October 1993 when he became associated with a FINRA regulated broker-dealer and its affiliate insurance company. In January 1994, Williams became registered with FINRA as a General Securities Representative ("GSR'? through associations with both entities, until April 1995. In January 1997, Williams became associated with another FINRA member as a GSR, where he remained until September 1999. At that time, Williams became associated with LPL Financial LLC ("LPL") where he served as a GSR until July 5, 2013. In August 2013, Williams joined another FINRA member, where he served as a GSR until July I, 2017. Williams is not currently associated with a FINRA member . .